The Market Thrill Of Being Scared By The Bear: Don Pittis

CBC

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Why do we like market scare stories so much? On a day when U.S. job numbers offer more proof of an economic recovery, it seems strange at first that investors should be so nervous. But clearly they are.

Earlier this week, the most popular story on CBCNews.ca was based on an interview from The Exchange with Amanda Lang with a single man, Hilliard MacBeth, who predicted a serious crash in the Canadian housing market.

(If you are one of the few who has not read the piece or seen Amanda Lang's interview, the miracle of the internet means you still have the opportunity to frighten yourself by clicking here.)

Bad news is bad for business

At the best of times, financial markets can unnerve adults the way bedtime ghost stories spook children. But many experts say we have just entered a new period of excessive fear for Canadian housing and for markets everywhere.

"We're having a shift in the monetary regime, arguably leaving this period of exceptionally low volatility for something that seems a bit more normal," said Russ Koesterich, chief investment strategist at BlackRock, a company that manages assets worth about $4 trillion US (yes that is trillion, with a T) of other people's money.

Overall, Koesterich's tone, especially regarding stocks, was relatively reassuring. But as with anyone holding a big stake, it is always hard to tell whether they are telling you what they really think — or what they want you to think.

His argument, expressed in an interview with Lang this week, was that the current instability in markets was mere "volatility," not a sign of an impending general market rout. He did not tell investors to prepare for the bear. However, what the BlackRock money man did not dispute is that the key driver of markets right now is that "shift in monetary regime" — the move from rock-bottom interest rates and cheap money to something else.

Don't poke the bear

Today's strong job numbers in the U.S., where unemployment fell to its lowest level since the 2008 recession, will put even more pressure on Janet Yellen at the U.S. Federal Reserve to stop printing money and start raising interest rates. Koesterich's point was that back when we were confident that the Fed would hold interest rates low, markets were safely on an upward track.

In the global context, bonds, which he called "expensive," could be the worst affected. And real estate? "It really depends on the market you're in," he said.

Earlier in the great recession, in a piece about investing in gold, I noted how much we like "doom" fiction, especially in times of uncertainty. My thought then was that by reading about worst-case scenarios, we sought to arm ourselves against every bad thing that might happen in the future.

In business, this is the respected field of scenario planning. In the news business, it is one theory about why people are so fascinated by unpleasant stories such as murders, car accidents and children's diseases. We want to know how to prevent them from happening to our own families. But when it comes to financial bad news, who can you trust to tell you the truth?

The majority of "experts" — i.e., those working in banking, stocks and real estate — all have vested interests. Certainly just before great market crashes, there is no shortage of professional optimism.

Bad news is bad for business. In the financial advice business, it is well known that even the gloomy news is understated.

Consider the source

Stock analysts who switch a company from "a strong buy" recommendation to "a weak buy" are seen as kicking the company in the teeth. "Sell" recommendations are mostly saved for companies at death's door. Politicians, public officials and even financial journalists are often loath to be the ones who send markets into a panic.

I think that is why, at such times, we look out for the rare people like MacBeth who are willing to describe a scenario where things are not all sweetness and light.

MacBeth's dire analysis, which led him to foresee a 40 to 50 per cent decline in house prices, is not something he made up. It is called "reversion to the mean," and when we look at the history of all financial markets, including real estate, we see it happening repeatedly.

Markets hit extraordinary highs and extraordinary lows, but history tells us that before going on to their next high or their next low, they bounce back to their long-term trend line, what you might think of as the average line over 50 years, with all the zigs and zags taken out.

What no one, including MacBeth, can know is when those reversions will happen. But I think it is an essential part of your investment planning to know that, whether in real estate or in stocks, bear markets do happen.

Big corrections possible

Currently a lot of people agree that the stock market is due for a correction, something like what Koesterich described as "volatility." A correction is defined as a drop of about 10 per cent. But while no one can predict the moment when it will happen, investors, and the people who manage our economy, cannot close their eyes to the fact that every so often — about 10 times since the Second World War — markets fall much further, often over a long period.

That is the 20 per cent decline of a true bear market.

This week, the head of the International Monetary Fund, Christine Lagarde, warned that gloom is not good for an economy.

“If people expect growth potential to be lower tomorrow, they will cut back on investment and consumption today," said Lagarde. "This dynamic could seriously impede the recovery, especially in advanced economies that are also grappling with high unemployment and low inflation.”

Today's jobs numbers from the U.S. tell us that there is no reason to be gloomy about the U.S. economy. We always knew the "shift in monetary regime" would lead to a rough patch on the way to recovery.

As Bank of Canada governor Stephen Poloz said recently, "So much debt has been taken on during the course of this downturn that every uptick in interest rates that we get is going to hit the cash flow of ordinary people."

Scary statements like that send a chill down my spine. They are so valuable because they are so rare. There is nothing wrong with indulging in the thrill of market scare stories and listening for what truths they may contain. But even stories that sound plausible are seldom complete.

If you had acted on the advice of those telling you to buy gold four years ago, for example, because the U.S. dollar and economy were about to crumble to dust, you would be sad today, as gold hits new lows for the year. The real value of scare stories is not necessarily that they are true.

Instead, they are valuable as a reminder that even when the vast majority of people are busy reassuring you that there is nothing to worry about, in financial markets, every once in a while, bad things happen.